Yesterday, the Dow closed up for the 5th day in a row, but just barely. Basically, Tuesday was a consolidation day. Lately, such pauses have punctuated a series of strong advances.
 
News flow was also downbeat yesterday. Various Fed officials noted the weak employment picture and the increasing prospects for a jobless recovery. Dennis Lockhart, president of the Atlanta Fed, warned that non-performing commercial real estate loans will be affecting smaller banks.
 Consequently, these troubled banks will not be making loans to small businesses, thereby crimping the recovery. If you are a small business person you know this is already the case.
 
In the technical section below we show a chart of the S&P Small Cap index, which is underperforming on this rally. We have been anticipating a thinning market as the major indices rose. A ‘thin’ market means a market with less broad participation. We have that now. The lack of volume and small-cap participation has some pundits worried, but it is par for a rally that is largely liquidity driven.
 
There is still good news from a sentiment perspective, however. Yesterday we noted that this is a skeptics’ rally. Mark Hulbert agrees. Although the stock market is near its yearly highs, Hulbert points out that the level of bullishness right now among short-term stock market timing services approximates levels from March, when the Dow was more than two thousand points lower.
 
Moreover, the average level of recommended equity exposure by short-term market timing services is just a few points above zero right now. The last time the Dow hit 10,000 (just two weeks ago), the mean recommendation was 25% invested. The last time the average recommended equity exposure among these market timing services matched these low levels was back in March. In other words, short-term timing services think this is the top. But tops are rarely obvious.
 
We noted a few weeks ago that one pundit calls this the most hated rally in Wall Street history. Such bearishness is a contrary indicator, suggesting further upside. Hulbert states it this way, “So, in effect, the market has figured out how to gain more than 30% while simultaneously preventing any new converts to the bullish camp. I’d have never thought it possible if you had presented me with such a scenario in advance.” These are impressive words coming from a man who has tracked market timers on a weekly basis for two decades.

MARKET CALLS

As the market advances, we expect the level of participation to decline as funds seek to build in a measure of perceived safety. That means underperformance from the small caps. It is now apparent.